Interest Rate Cut Alone May Not Be Enough

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SaigonTimes English - 30 month(s) ago 9 readings

Interest Rate Cut Alone May Not Be Enough

The Prime Minister has requested the central bank to lower interest rates by one percentage point across the board. This is a justifiable policy as inflation tends to ease and the banking system’s liquidity is no longer as tense as it was in end-2011. Yet is a lower interest rate alone able to give a boost to the whole economy?

Interest Rate Cut Alone May Not Be Enough

By Bui Trinh & Le Hoa

Interest rates are being cut. However, lenders' problem will be how to find enough borrowers
The Prime Minister has requested the central bank to lower interest rates by one percentage point across the board. This is a justifiable policy as inflation tends to ease and the banking system’s liquidity is no longer as tense as it was in end-2011. Yet is a lower interest rate alone able to give a boost to the whole economy?

Recently, government policies have been focused mainly on monetary issues to harness price hikes. They have, however, failed to pay adequate attention to other factors. Take inflation for example, where monetary solutions have touched the peripheral, not its core, because what lies at the root of the inflationary problem are ineffective production and investment.

A look at investment efficiency either from ICOR (Incremental Capital Output Rate) or TFP (Total Factor Productivity) shows current deep plunges. Vietnam’s ICOR rose from five in the 2000-2005 period to seven in 2006-2010. Likewise, if TFP accounted for some 22% of gross domestic product (GDP) in 2000-2005, it has currently dropped to below 10% (some even say that the rate may be as low as 1%!). Furthermore, from the standpoint of added value, the situation is even worse. In 2000, every 10 dong worth of production would generate four dong in added value. This rate is 19-3 now, or even less than 3. As such, that greater capital is used only to manufacture products of lower value will break the goods and money market equilibrium and push costs of local products.

During the entire 2011, the State persistently implemented the money tightening policy to harness inflation. This policy nonetheless seemed to ignore the corporate sector which is the backbone of the economy. Many businesses have died and a lot more are moribund. In the first quarter of 2012, some concerns which were on the verge of dying in 2011 have kicked the bucket and several others become moribund. More often than not, these businesses are non-State enterprises whose aggregate production accounts for almost half of the national GDP. Meanwhile, State-owned enterprises and the foreign direct investment sector with lower investment efficiency (*) have fared better. What will happen if non-State entities have to go bankrupt or see their production plans scrapped or shelved? Stagnant production will lead to lower gross added value of the entire economy. When production stalls, the purchasing power will follow suit. Sooner or later a demand crisis will arrive, and the crisis spiral will become worse and never end.

A scrutiny can show that difficulties encountered by small and medium scale enterprises relate to not only high interest rates but also the following issues:

• The corporate sector suffers from inaccessibility to capital. Even when capital can be accessed, the borrower in question must bear exorbitantly high interest rates. As capital-starved businesses fail to expand production, the economy will take a heavy toll.

• While transport infrastructure remains weak, businesses have to shoulder too many fees while transporting goods through distribution. What follows is higher production costs which in turn result in higher selling prices and rising consumer price index while corporate profits remain the same. In other words, added value generated by companies does not increase and production efficiency gets stuck.

• Time-consuming and complicated administrative formalities have deprived companies of business expansion chances, particularly in the export industry. This is one of the reasons for ineffective production and higher intermediate costs.

• Informal charges should also be taken into account, for instance, contributions to government-led functions or festivals.

Furthermore, Vietnam has one of the highest tax ratios to GDP in the world (between 25% and 27%). Let alone, underground fees are pervasive and inflation tax so high. As such, Vietnamese businesses are under so many kinds of pressure.

The Prime Minister has recently ordered an interest rate cut of one percentage point. This is justifiable as inflation tends to fall and liquidity is no longer as tense as it was in the last months of 2011. However, is such a rate cut alone able to lift the entire economy? After a prolonged period of credit tightening, interest rates soared and production stalled making many companies bankrupt. The lackluster performance of the corporate sector plus high inflation tax has crippled much of working people’s income. The inevitable outcome is that end-users’ purchasing power has dramatically decreased.

Domestic production is facing formidable challenges. An An Giang-based business owner has put it, “Ailing banks will be bailed out by the State! How about moribund companies? Who will save us?” Despite an interest rate cut, who will be able to get loans?

From another viewpoint, can the Vietnamese economy place its hope on exports? This depends largely upon growth and the purchasing power of other economies. But it should take into account the bleak global economy and fluctuating world prices. Forecasts show that Vietnam’s export in 2012 may not be as strong as it was last year because exporters are not willing to take risks with bank loans.

All in all, as the three factors of total domestic demand—including consumption, investment and export—forming the GDP are likely to become lower, production will find it hard to rise. That said, the risk of a returning high inflation will loom large and the goods and money market equilibrium will be broken again.

Given such a backdrop, the central bank should revise its policies opportunely, which can be loosening the grip on either selected realty loans or controlled consumer loans. At the same time, to help businesses survive this hard time, local governments should join forces with the central government in streamlining administrative procedures and minimizing underground fees.

(*) During the 2006-2011 period,
ICOR of the non-state sector in Vietnam was about four, that of the State sector was 9.7, and that of the foreign direct investment sector was over 10.

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